1.You are a senior manager of a firm in Florida that manufactures a range of toys locally only. Your revenues come from two products- plastic toys with no moving parts, requiring simple assembly, and electric toys with moving parts, requiring precision & skilled assembly. Your CEO has made a recent trip to Asia and has discovered the wonderful world of low labor cost South East Asian countries. She concludes that the company should shift production of part of their products at least to some of these countries, reckoning that the company could cut production costs substantially. After further research, she discovered that labor costs in Pakistan are Rs.100 per hour compared to $9 in Florida. When she learnt that the current exchange rate is Rs.20/$, she was convinced that she should move all production to Pakistan.
You, however, have had the benefit of attending the international business course at FIU, and so investigate further before carrying out the CEO's bidding. You determine that your CEO was right about the labor cost differences being the single most important determinant of your costs. Since you are buying components and only assembling them, the raw material costs did not vary depending on where you manufactured. Therefore, she seemed to be on the right track in arguing that Pakistan would be the cheaper location. Nevertheless, you dig deeper and find the following data (assume no quality differences, zero transportation costs, etc.):
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Toys produced /unit of labor
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Plastic
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Electric
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Pakistan
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3 OR
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2
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USA
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6 OR
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6
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a) What are the opportunity costs of producing each of these goods in each country?
b) Based ONLY on the data in the table (i.e. ignoring wage rates), would you move ALL production to Pakistan? If so, why? If not, would you move one product to Pakistan? If so, which one, and why?
c) Now include the wage rates in your analysis. What would you recommend to the CEO? If you recommended moving any production to Pakistan, justify your decision. If you recommend not moving any production to Pakistan, justify your decision to the CEO by determining
i. The wage level at which it would be optimal to move some production to Pakistan ii. The wage level at which it would be optimal to move all production to
d) What are the limits to the exchange rate at which it makes sense to produce at least something in both countries?
2. We talked in class about free trade areas, customs unions and common markets. We also discussed basic principles of the WTO, including trade should not be discriminatory and should head in the direction of fewer rather than more barriers. And finally we discussed the welfare impacts of tariffs and other trade barriers on a country, including consumers, producers and government. Suppose three countries US ($8), Mexico ($6) and China ($4) make a good at the prices in parenthesis. Now consider the following alternative scenarios:
- Scenario 1: The current tariff rate is $5
a. If there are no free trade arrangements, from which country's producers will US consumers buy the product?
b. If we now signed NAFTA, from which country's producers will US consumers buy the product?
c. Are US consumers and the country as a whole better off or worse off with NAFTA and why?
- Scenario 2: The current tariff rate is $3
d. If there are no free trade agreements, from which country's producers will US consumers buy the product?
e. If we now signed NAFTA, from which country's producers will US consumers buy the product?
f. Are US consumers and the country as a whole better off or worse off with NAFTA and why?
g. What is the difference in the two scenarios? What does that tell you about the impact of free trade agreements?
3. Consider a country that is closed to international trade. Suppose that when this country opens its borders for trade and allows market forces to work freely, it begins to import textiles, a labor intensive good.
a. What does this imply about country A's factor endowments and why?
b. What is likely to be the effect of trade on wages? Explain why?
c. Which group of citizens in country A would you expect to support free trade and why? Why would oppose free trade and why?
4. Figure 1 below describes the hypothetical demand (D) and supply curve (S) for sugar in
Small country X. Assume that autarky (no trade) equilibrium price for sugar is $540. Under free trade, country X faces a constant world price of sugar equal to $400 per ton. At the free trade price, consumption is 40 tons, while production is 5 tons. The leader of this country, not having had the fortune of attending FIU, tries to protect domestic producers by imposes a tariff rate import quota of 5 tons- imports within this quota of 5 tons face a tariff of only 10%, while a 20% tariff applies to any imports beyond the 5-ton quota. The figure shows the impact of this structure on domestic price, consumption and production. (The numbers are for reference only, you do not need to calculate anything.)